Dark pool disquiet resurfaces in US – TABB

US institutional investors are concerned about the market quality implications of growing off-exchange trading volumes, but are unclear on how much of their own trades are executed in the dark, according to TABB Group.

US institutional
investors are concerned about the market quality implications of growing
off-exchange trading volumes, but are unclear on how much of their own trades
are executed in the dark, according to TABB Group.

While the
research firm’s eighth annual benchmark study of US institutional equity
trading found 60% of survey participants believed off-exchange activity was now
impacting market quality, almost two-thirds (63%) could not confirm the
percentage of their algorithmic flow which is executed in dark pools.

The study also
found around two-thirds of buy-side firms “had trust issues” with dark pools.
Institutional investment firms in the US and globally carried out intensive due
diligence on their use of dark pools and brokers’ order routing mechanisms
after Pipeline Trading Systems was fined[/newsarticle.aspx?id=7232] in October
2011 for failing to disclose that the vast majority of its orders were executed
by an affiliated trading firm rather than buy-side counterparts.

In June, the US
Securities and Exchanges Commission (SEC) investigated alleged shortcomings in
how Liquidnet protected information about clients which use its block trading
platform. In October 2012, the SEC fined Boston-based eBX US$800,000 for
failing to inform participants in its LeveL ATS alternative trading system that
orders were being routed to a third-party technology firm, Citi’s Lava Trading,
which fed the information into its order routing business.

TABB Group research
analyst Cheyenne Morgan said current practice in use of algorithms to access
dark pools made it difficult to track execution. “Most traders access dark pools by using algorithms, which can make
visibility into final execution venues difficult. Each algorithm is typically
connected to several dozen venues and may route to multiple destinations before
finding a suitable match, making transparency problematic. Adding to the
challenge, traders typically use multiple algorithms throughout the day for
various orders,” she said.

The TABB study also revealed
concerns among US buy-side firms over the growing consolidation of sell-side
execution services, with almost seven out of ten survey participants asserting
the importance of maintaining anonymity between high- and low-touch services.
Noting declining commission wallets in line with trading volumes, Morgan said,
“Maintaining client trust while consolidating multiple roles into a
single-touch point will no doubt prove challenging but is a must in today’s
environment.”

The study is based on interviews
conducted in August and September 2012 with 66 head traders of US institutional
equity management firms controlling a total of US15 trillion in assets under
management.